Quantifying Risk. A Look At Commodity Risk and Country Risk Interaction

Transcription

1 Quantifying Risk A Look At Commodity Risk and Country Risk Interaction Paul Robinson Senior Economist, IHS Pricing and Purchasing Service 17 April 2013

2 About IHS Pricing & Purchasing The IHS Pricing & Purchasing Service enables supply chain cost savings by providing timely, accurate cost and price analysis. Armed with a better understanding of suppliers' cost structures and market dynamics, organizations can effectively negotiate prices, strategically time buys, and boost the bottom line. With a database of more than 80,000 historic prices and thousands of price, wage and input cost forecasts, IHS offers more coverage than any other provider in the market. IHS has been providing forecasts of key commodity, labor, and input costs since helping define the purchasing advice industry. Learn more, visit ihs.com/pricingpurchasing 2

3 Agenda Volatility explained: What is it and why does it matter? Where have we been: A recent history of volatility Building commodity risk ratings: A way to quantify the interaction of country risk and commodity risk Commodity Market Overview Automotive Materials Update 3

4 Agenda Volatility explained: What is it and why does it matter? Where have we been: A recent history of volatility Building commodity risk ratings: A way to quantify the interaction of country risk and commodity risk Commodity Market Overview Automotive Materials Update 4

5 Volatility Explained What is it? Variation in price over time How is it measured? Standard deviation CBOE s VIX (equities) Implied volatility in S&P 500 index options risk compensation Why does volatility matter to you? Timing buys Coping with changing inventory values Makes planning more difficult 5

6 Agenda Volatility explained: What is it and why does it matter? Where have we been: A recent history of volatility Building commodity risk ratings: A way to quantify the interaction of country risk and commodity risk Commodity Market Overview Automotive Materials Update 6

7 Recent History of Volatility Standard Deviation of MPI (52-Week Moving Average) Chicago Board of Options Exchange VIX Index

8 Volatility Drivers Micro Just in time inventory (JIT) Inventory/Shipments Ratio Lengthening supply chains Example: Japan earthquake Supply boom/bust cycles Example: Shipping

9 Volatility Drivers Macro Monetary policy liquidity Exchange rates - dollarization Exchanges (ETFs)/High frequency traders Country risk MPI (2002 = 1.0) - Left Trade-Weighted Dollar Exchange Rate (1973=100) - Right 9

10 Agenda Volatility explained: What is it and why does it matter? Where have we been: A recent history of volatility Building commodity risk ratings: A way to quantify the interaction of country risk and commodity risk Commodity Market Overview Automotive Materials Update 10

11 Premise A key part of the risks associated with buying a given commodity is the risk of the country you are sourcing from Items such as Conflict Minerals have gotten a lot of attention, but the truth is that the operating environment in many countries is subject to high levels of risk We can develop a quantitative method for capturing country risk as a way of better understanding commodity price volatility 11

12 Selected Commodities Energy Oil Coal Natural Gas Ferrous Metals Iron Ore Non-Ferrous Metals Aluminum Chromium Copper Lead Manganese Molybdenum Nickel Tin Zinc 12

13 1. Gather the (Production) Data Energy Oil (IEA) Coal (World Coal Association) Natural Gas (IEA) Ferrous Metals Iron Ore (USGS) Non-Ferrous Metals Aluminum (WBMS) Chromium (WBMS) Copper (WBMS) Lead (WBMS) Manganese (WBMS) Molybdenum (WBMS) Nickel (WBMS) Tin (WBMS) Zinc (WBMS) 13

14 2. Ranking the Largest Producers 14

15 3. Calculating the Concentration Ratios Highly concentrated production is risky in any country Capture difficult risks like weather (Australian floods) and geography (Straits of Hormuz) Calculate share of top 4 producers Iron Ore Millions of Metric Tonnes China 1300 Australia 525 Brazil 375 India 245 Top 4 Total 2445 Global Production 3000 Top 4 Concentration Ratio

16 4. Developing Country Risk Scores Calculate scores for additional country specific risks IHS Country Risk services Mining sub-category 16

17 5. Weight Country Risk Ratings by Production Simple weighted average of the individual country risk ratings to create a commodity risk rating Multiply by the concentration ratio from step 3 to take into account additional risks Commodity Top 4 Producing Countries Production IHS Country Risk Rating Top 4 Weighted Average Risk Rating Iron Ore Total 3000 China Australia Brazil India

18 6. Gather the (Price) Data Energy Oil (IMF) Coal (IMF) Natural Gas (IMF) Ferrous Metals Iron Ore (IMF) Non-Ferrous Metals Aluminum (LME) Chromium (AMM) Copper (LME) Lead (LME) Manganese (AMM) Molybdenum (AMM) Nickel (LME) Tin (LME) Zinc (LME) 18

19 7. Calculate Standard Deviations...Or just let a computer do it for you 3 Year standard deviation of the monthly percent changes of each variable 19

20 8. Interpreting the Results 20

21 Assessing the Outliers Natural Gas Why is natural gas more volatile than its scores show? Seasonality Difficult to store/move Artificially low score (United States) 21

22 Assessing the Outliers Tin Why is tin less volatile than its scores show? Hedging (LME) Long history operating in elevated risk countries Mines close to ports or even offshore 22

23 SURPRISE! Oil and Copper Low Risk/Low Volatility? Still volatile, just not as volatile as some Growing production in United States; Growing stability in Chile 23

24 Conclusion This is just the beginning Improvements: Build commodity risk scores based on exports, not production Group oil producers locked within the Straits of Hormuz with Iran s score Go build commodity risk scores! 24

25 Agenda Volatility explained: What is it and why does it matter? Where have we been: A recent history of volatility Building commodity risk ratings: A way to quantify the interaction of country risk and commodity risk Commodity Market Overview Automotive Materials Update 25

26 Crises Averted, Worries Remain Good news: global growth has stabilized. Monetary stimulus and deleveraging are setting the stage for a modest acceleration Bad news: risks abound the never ending Eurozone crisis, the US sequester and frothy Chinese property markets are all headwinds to better growth For Supply Chains: Growth is not fast enough to tighten markets and trigger general price increases But not slow enough that prices slump Commodity prices look to move sideways (like 2012), though with an upward drift as we move into 2014 (unlike last year) 26

27 Backlogs and Delivery Times Still Show Buyer s at a Slight Advantage 60 Global Purchasing Managers Indexes Buyers Advantage Backlogs (LHS) Delivery Times (RHS) 64 Higher delivery time numbers correspond to faster deliveries (scale inverted) Source: Markit 27

28 Automotive Material Costs Chart (2000 = 1.000) 3.0 A Range-Bound Outlook *Weighted average of key material costs such as steel, plastics, aluminum, rubber, and glass Excludes Fuel, Processing and Transportation costs

29 Agenda Volatility explained: What is it and why does it matter? Where have we been: A recent history of volatility Building commodity risk ratings: A way to quantify the interaction of country risk and commodity risk Commodity Market Overview Automotive Materials Update 29

30 Oil Energy Chemicals Steel Nonferrous The buying environment for oil will be more favorable in the near term Sourcing Guidance: Oil prices will fall, beginning in the second quarter of Q2 One Year Ahead (2014Q1) Prices Lower Lower Demand Neutral Stronger Supply Ample Ample Demand - Global oil demand growth will be positive in 2013 but not as strong as A second straight year of Eurozone recession will dampen global demand in the near term + The geopolitical risk premium will persist through 2013 Supply - Inventories are building and production expansions will keep the market well supplied in Unconventional plays will continue to gain popularity in 2013, increasing global supply - Saudi Arabian interest in shale drilling bodes well for OPEC supply growth Prices Prices remain elevated in the near term but will move lower though 2013 Brent prices should fall below $100/barrel by the second half of the year

31 Petrochemicals Energy Chemicals Steel Nonferrous The buying environment for petrochemicals remains mixed. Sourcing Guidance: Chemical prices will correctly modestly in the second quarter as oil prices fall 2013Q2 Plastic Resins Price Outlook One Year Ahead (2014Q1) Ethylene Flat Lower Propylene Lower Lower Polyethylene Flat Lower Polypropylene Lower Lower PVC Higher Higher HDPE, USA (Cents/Pound; Left Scale) Polypropylene, USA (Cents/Pound; Left Scale) HDPE, EU (Euro/Metric Ton; Right Scale) Polypropylene, EU (Euro/Metric Ton; Right Scale) Demand + Modest improvement in downstream demand and production issues tighten the spot ethylene market. In the US, polyethylene demand is quite strong, especially for exports. - Improvement in ethylene demand has not been fully matched by increased demand for propylene derivatives. Supply + Production issues in the US and flat-to-falling inventories push sellers into a better negotiating position. + In Europe, with relatively stable costs, cracker margins remain at reasonable levels Prices Price gains in the first quarter will not last throughout the year Expect softer prices in the second quarter

32 Steel sheet Energy Chemicals Steel Nonferrous The buying environment for hot-rolled sheet will be slightly more favorable in the second quarter Sourcing Guidance: Waiting to buy until late spring will yield positive results 2013Q2 Prices Lower Flat Demand Weaker Neutral Supply Neutral Tight One Year Ahead (2014Q1) Demand Improving fundamentals in North America will lift prices in the third quarter Chinese and European demand are looking worse over the immediate near term Supply Iron ore shortages will create a seasonal bump to prices General restocking led prices higher in the first quarter Prices Steel sheet prices should peak sometime near March and decline soon after Delay buying if possible to take advantage of lower prices

33 Copper Energy Chemicals Steel Nonferrous The buying environment for copper will remain neutral in the second quarter Sourcing Guidance: Prices will be tightly range bound in the near term, before moving lower in Q2 One Year Ahead (2014Q1) Prices Flat Flat Demand Neutral Weaker Supply Ample Ample Demand The new copper ETFs being introduced by JP Morgan and Blackrock Investment Management will be non-factors in the market Supply Large exchange stock increases and weak prices over the past month have reaffirmed our view that copper is transitioning to a surplus market condition A large deposit in the LME Singapore warehouse creates anxiety about the strength of East Asian demand and about the size of "hidden" inventories in China Prices The bottom line for copper is that a surplus market condition undercuts support for prices at current levels Prices are headed lower with a correction on the order of $1,500/metric ton a real possibility over the next six quarters

34 Aluminum Energy Chemicals Steel Nonferrous The buying environment for aluminum will be less favorable during the second quarter of 2013 Sourcing Guidance: It is hard to be anything but pessimistic about aluminum over the near term 2013Q2 One Year Ahead (2014Q1) Prices Slightly Higher Slightly Higher Demand Slightly Stronger Weaker Supply Ample Neutral Demand Consumption appears to be slowing A contango in the forward curve makes financing deals less attractive Supply Production cuts are beginning to move the market back toward balance The decision by China's State Reserves Bureau to purchase 300,000 metric tons of metal is symptomatic of aluminum's chronic oversupply condition Prices Prices have dropped under $1,950 per metric ton on the London Metal Exchange (LME), well into the cost curve, limiting the downside But the upside is equally limited by projected surpluses in both 2013 and 2014 and the huge existing inventory overhang

35 The bottom line A flare of up political risks have undermined momentum in markets European and North American concerns have moved back to the forefront of pricing The prospect of a lengthy sequester has downgraded US GDP Growth rates are now forecast at 1.8% for 2013 Commodity markets will be only tangentially affected European markets have again been besieged by political risks A slew of elections in the Eurozone will challenge the resolve of current policy makers Problems in Cyrpus underscore the risk that still remain Long term debt problems and chronic unemployment threaten the medium term recovery Chinese indicators will be very important in coming months The growth profile of China will be the driver of myriad commodity prices Overall, we assume a modest acceleration in growth with top-line GDP advancing 8.2% this year Energy prices are diverging Oil prices are going to fall based on fundamental supply expansion, but the political risk premium persists Conversely, natural gas prices will move higher throughout most of 2013

36 Thank you for your time Questions? Paul Robinson Senior Economist IHS Pricing and Purchasing Service 36